A market crash should provide lessons for every investor, although far too many have short memories. In March 2000, the stock bubble popped. By the fall of 2002, the S&P had declined 46% percent from its peak and the NASDAQ lost a staggering 72% percent of its gain, known as “giving back.”
Mutual funds were not immune to the fall. There is only so much a fund manager can do to avoid having their funds follow the market. They suffered equally – to the surprise of most of their shareholders – who expected their managers to outperform the indexes. They were paying good money for the expertise of these managers, and they didn’t seem to be getting it. Stock mutual funds declined en masse and some of the high-profile funds gave back much more than the S&P 500. Even balanced funds, those invested in both stocks and bonds, suffered, to the dismay of investors who selected them as a more conservative investment.
Billions of dollars flowed into aggressive growth and technology funds in the late 1990s as a result of mutual fund companies spending millions on advertising and pushing their high-flying funds. Remember those days when you couldn’t open a newspaper or magazine without seeing a mutual fund company touting its funds? It was those aggressive growth and technology-heavy funds that touted glowing track records, as if these exorbitant returns would continue forever.
Listening to chants from financial analysts that “this time is different,” most of the shareholders of the hottest funds came on board in 1998-1999, just in time for the bear market’s emergence from hibernation in 2000. The high-profile funds lost altitude quickly. Unfortunately, the fund companies weren’t handing out parachutes to shareholders.
As the stock market decline worsened, mutual fund call center phones rang off the hook. Shareholders were holding the line, and they wanted some answers about their deteriorating savings. The mandate came down from mutual fund management: Tell the shareholders that ups and downs are natural for the stock market, and that it’s more important not to panic and to adopt a “long-term perspective.” That had to be a reassuring thing for someone just a few years from retirement to hear.
Back then, being a phone rep for a fund company must have been like working in the complaint department at White Star Line Shipping in 1912, the year in which the Titanic sunk. The fact is, investors got caught up in the hype of the stock market boom of the 1990s, and fund companies did little to protect investors from what was coming. In fact, many saw an opportunity to capitalize, and they did just that.
In the wake of the market decline, the scandals, and the realization that few funds outperformed their benchmarks, the number of mutual funds began to consolidate. Today there are a little more than 8,000 mutual funds, down from a high of 11,000 at the market top in 2000. Each year, 300 to 500 mutual funds are lost because poor- performing funds are being killed off or merged with other funds that have better track records.
Enter the exchange traded fund (ETF).
Much like mutual funds during their rapid growth period, ETFs are sprouting up like June corn in an Iowa field. After hitting the market in 1992, ETFs now hold nearly $600 billion in assets in nearly 600 funds. Considering that only 32 funds were trading in 1999, representing only $36 billion, their ascent has been dramatic. By comparison, the mutual fund industry, which began in 1924, took 60 years to reach the same asset level that ETFs enjoy today. The exchange traded fund market is expected to grow 33 percent annually until 2010, reaching almost $2 trillion.
Some days several new ETFs come to market. And if there isn’t an existing index – say, something for a particular country or currency – ETF providers will go ahead and create an index and build an ETF around it if there’s enough interest. Although the first – and, by far, the most popular – ETFs were the traditional ones that track stock indexes, an ever-growing variety of ETFs cover specialized sectors and markets (stocks, currencies, commodities).